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Lec 12: The Gold Standard I. Intro: Why bother with Gold? II. The Gold Standard as an Ideal Type III. Breaking the Rules of the Game IV. Brief History of the International Gold Standard V. Conclusion 3

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Lec 12: The Gold Standard I. Intro: Why bother with Gold? II. The Gold Standard as an Ideal Type III. Breaking the Rules of the Game IV. Brief History of the International Gold Standard V. Conclusion 4

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Historical Significance Provides insight into most of monetary history Integral to First Era of Globalization Enduring legacies in contemporary system –International Monetary Fund –Distribution of worldwide gold supply 5

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Intellectual Significance Robust alternative to current system of floating ERs Lessons from First Era of Globalization Parallels with current crises –Chinas dirty float –Constraints and opportunities generated by currency union (e.g. Euro) 6

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Lec 12: The Gold Standard I. Intro: Why bother with Gold? II. The Gold Standard as an Ideal Type Breaking the Rules of the Game Brief History of the International Gold Standard Conclusion 7

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II. THE GOLD STANDARD AS AN IDEAL TYPE 1. The Gold Standard Rules 2. Purchasing Power Parity 3. The Automaticity of the Gold Standard

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Remember our understanding of an exchange rate: the valuation between the domestic currency and foreign currency/currencies. 9

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In theory, the gold standard (GS) was an exchange rate regime that related the member countries currencies through their valuations to gold. 10

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PPP versus Market Rates Implied PPP (from gold prices): $1 = £0.695 If I can trade $1 for £0.695, I should be able to buy gold at the same price in GB and in the US BUT Market Exchange Rate: $1 = £0.691 Why the difference? Why doesnt arbitrage eliminate the difference? 21

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II. THE GOLD STANDARD AS AN IDEAL TYPE 1. The Gold Standard Rules 2. Purchasing Power Parity 3. The Automaticity of the Gold Standard

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The GS was meant to automatically ensure both the quantity of money in the world and the distribution of money around the world. 29

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GS Regulation of Quantity Official/Mint Price: price of gold in terms of local currency Free Conversion: monetary authority should… –Purchase gold with currency at the official price –Sell gold for currency at the official price Automatic Quantity Adjustment –Overvalued currency sell currency for gold decrease in currency and increase of gold –Undervalued currency sell gold for currency increase in currency and decrease in gold Sustained increases in gold price mining 30

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By regulating the quantity of currency automatically, adherence to the GS would theoretically ensure domestic price stability. After all, if the official ER did not match the PPP, currency/gold would be converted. 31

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(1) Maintain Exchange Rate Stability (gold parity) 12 --> the monetary authority commits to doing everything in its power to ensure that the market ER with gold remains at the predetermined, official parity.

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(2) Maintain Convertibility between Domestic Currency & Gold. --> No restrictions on the purchase/sale of domestic currency/gold. No restrictions on the import/export of gold or currency.

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But remember the balance of payments constraint. States only have a few ways to reconcile imbalances of payments...

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The result is that the exchange rate remains stable, domestic prices and incomes remain stable, and the government simply amasses foreign reserves. This saves the surplus country from having to adjust today. It also provides reserves for a rainy day in the future. 50

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But it also shifts the burden of adjustment entirely onto the shoulders of the deficit country. And it creates competition for reserves. 52

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This is what the US and France did in the 1920s. And this is largely what China is doing today. 53

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Lec 12: The Gold Standard I. Intro: Why bother with Gold? II. The Gold Standard as an Ideal Type III. Breaking the Rules of the Game IV. Brief History of the International Gold Standard Conclusion 54

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Here are a few of the highlights of the emergence and ascent of the international GS. 55

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My Assessment Hamilton was lazy –Did not bother with important technical details –Just copied Britain But he had political savvy –Won public debate by citing British example –Got backing of powerful financial elites –Had Washingtons ear Jefferson was a philosopher –Better understanding of technical details –But too abstract and reactionary for public –Did not build a coalition in time 62

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Maggie and Me at the First Bank of the United States in Philadelphia 63

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Lec 12: The Gold Standard I. Intro: Why bother with Gold? II. The Gold Standard as an Ideal Type III. Breaking the Rules of the Game IV. Brief History of the International Gold Standard V. Conclusion 68

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The gold standard certainly seems dated. None of us had been born when the international gold standard system collapsed in the 1970s. But there are good reasons to understand it… 69

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Importance of Gold Era of fiat currency (1971-present) is vast exception to rule; commodity currency has been norm Will the new era endure? –Nth Currency is a national currency –Can governments be trusted with fiat currency? Key insights useful to new era –Emergence of capital controls in China –Challenges in EU: integration versus domestic policy autonomy 70